Lending rates fell in March from their February levels, but a simultaneous need to raise deposit rates may be causing spreads to peak out. The marginal lending spread — the interest rate on new loans minus new deposits — for the banking system has come off peak levels and declined by 16 basis points (bps) in March over February 2021, according to data released by the Reserve Bank of India (RBI).
At the same time, spreads remained high at an average of 4.6% for private banks and 3.2% for public sector banks (PSBs). The spread between the average lending rate on outstanding and fresh loans was 120 bps. While headline rates have fallen, spreads between long-duration and short-duration as also between AAA and AA have remained elevated, suggesting the spreads over loans both in products and duration is quite high, said Kotak Institutional Equities (KIE)
Analysts said a number of factors may have contributed to keeping spreads high despite a lack of credit offtake. These include the share of fixed-rate loans in the mix, higher-yielding unsecured loans (which are also fixed-rate) and pricing that seeks to offset the impact of higher bad assets.
Banks had earned higher spreads through the Covid phase as credit disintermediation was low and they could price products better, according to a note by Nomura. This could be set to change. “Assuming the cyclical recovery in loan demand picks up, banks may need to raise their retail deposit rates, even as wholesale deposit rates are off the lows since Jan-21. With new loans priced off the ‘repo’, a slower monetary policy move by the RBI may be negative on NIM, at the margins,” the broking firm said.
Also, the recent decline in spreads occurred largely on the back of a fall in average lending rate on new loans for foreign banks, which fell 80 bps month on month (MoM) in March. At a system-level, the average lending rate on new loans declined only 16 bps. In fact, lending rates rose 16 bps for private banks on an M-o-M basis.
Rate transmission is, therefore, far slower than what the headline numbers suggest. “In a relatively low growth and heightened risk environment, especially after Covid, we note that the spreads have continued to remain high,” KIE said, adding that the spread over G-secs with deposits and loan rates has widened. This implies banks are seeing a lower spread on investments and better spreads on loan yields.
Recently, State Bank of India (SBI) chairman Dinesh Khara said that the bank shall try to keep interest rates low for as long as possible with a view to supporting economic growth. It is not clear how long banks will be able to do this, especially considering a string of deposit rate hikes has already taken place. SBI, Housing Development Finance Corporation (HDFC) and Canara Bank have raised deposit rates in recent months.